Independent contractors fulfill varying roles, and there’s a lot of grey area when it comes to differentiating between contractors and employees. Delineating the difference between the two classifications can sometimes prove difficult. However, common law principles, Fair Labor Standards and various court decisions establish guidelines for understanding the difference. Additionally, the Internal Revenue Service (IRS) and some states have adapted various rulings as a framework for testing the status of workers.
One important reason for discerning the difference between employees and contractors is that the IRS mandates different employer tax liabilities for the two roles. For instance, employers must deduct social security tax, state and federal unemployment taxes and worker’s compensation and disability premiums for the State Worker’s Insurance Fund (SWIF). Conversely, employers aren’t responsible for making any of these deductions and payments on the behalf of independent contractors.
Employers who mistakenly classify employees as independent contractors may find that they are liable for collecting overdue taxes, so it’s important to seek the help of a qualified professional to verify proper employee/ independent contractor classifications. There are safe harbors that allow employers to classify workers as independent contractors without penalty, such as a history of hiring similar workers as independent contractors or IRS audits that did not result in the need to pay back taxes for workers.
Understanding the Difference Between Employees and Contractors
Sometimes, confidently establishing the right classification can prove difficult when employers pay independent contractors and employees for similar work. However, there are important legal differences between the two statuses. The degree to which an employer controls what a worker does and how they complete their work can affect classification. Also, whether an employer manages administrative and other business-related facets for a worker can make a difference. This can encompass payment arrangements, expense reimbursements and the supply of tools and production materials.
Lately, revised state laws have made it increasingly difficult to classify workers as independent contractors, and each state has its own guidelines that determine whether a worker is an employee or an independent contractor. Whether a written contract exists, or if an employer provides access to benefits such as health insurance and retirement savings, can also affect worker classification. Also, whether the business relationship is ongoing and the tasks completed by the worker are essential to the enterprise mission are important for discerning the difference.
Why the Right Classification Matters
The delineation between employees and independent contractors has several legal and financial implications. In addition to withholding taxes, if an individual works overtime, the employer must pay that worker in accordance with state law if they are legally classified as an employee. Conversely, independent contractors pay their own self-employment taxes, and typically works as long as it takes to complete a project for predetermined rate that doesn’t include increased pay for working extra hours.
From the perspective of the IRS, distinguishing between employees and independent contractors is vitally important for establishing clear accountability for who is responsible for paying taxes. However, various agencies may acquiesce to different authorities when deciding how to interpret distinguishing guidelines. The Department of Labor, for example, defers to the opinions offered by the Supreme Court regarding independent contractor statuses. Under the Supreme Court’s ruling, there’s no singular test that can definitively establish whether a worker is an employee or independent contractor for the purposes of the Fair Labor and Standards Act (FLSA). The court did rule that how much control an individual has over their work and production is a strong determinant of status. Where an individual completes their work and whether that person must obtain state licensure is typically unimportant in establishing the status of a worker.
The IRS emphasizes the importance of proper worker delineation to ensure the efficient and effective collection of taxes. One guideline that the agency recognizes is that an individual is typically an independent contractor if their business arrangement allows them to control the final output of their production. Additionally, the IRS considers how much a worker depends on a single employer for income. However, these are not the only deciding factors. Each employee or independent contractor arrangement must withstand its own scrutiny based on the facts at hand. For further examination, the agency investigates three variables; behavioral control, financial control and the relationship of the parties.
As more people search for ways to take control of their economic prosperity, the employee/ contractor issue will become more commonplace for American business owners. The lines of classification are growing hazy in an economic environment where independent contractors fluctuate between working for several employers and one client at a time, and as more American enterprises enter non-traditional business arrangements, where workers can complete tasks outside of the office, knowing the right worker classification will grow increasingly important.